ECONOMIES OF SCALE
CONTENTS
What are economies of scale?
Technical economies
Specialisation economies
Purchasing economies
The advantages of economies of scale
Activity 3.12.1 Munchester Taxis

What are economies of scale?
Economies of scale is a term used to describe certain benefits that a business gains from increasing its
scale of production. However there may also be disadvantages associated with large-scale production.
These are known as diseconomies of scale.
Supposing that you become deeply enthusiastic about cornflakes, (a mass-produced breakfast cereal).
You decide to set up your own company producing cornflakes in your kitchen. Would you be able
to compete with existing manufacturers such as Kelloggs? Could you make a profit from selling your
cornflakes at the same price as those made by Kelloggs, who produces cornflakes on an enormous
scale? You would probably find that the unit cost of production, marketing budget and expertise of
Kelloggs would make it very difficult for you to get consumers interested in your product.
There are three important kinds of economy of scale. These are known as technical economies,
specialisation economies and purchasing economies.
Technical economies
Technical economies are those linked to the ability of larger firms to make savings through investing in
bigger or more cost-effective machinery and equipment. Some examples of technical economies are
set out below.
• Sophisticated IT systems to collate and process data can be a way to improve efficiency
and production capacity. However, this technology is probably only affordable for
businesses operating on a certain scale.
• Mass production techniques involving high levels of automation can improve labour
productivity. For example, the use of robots for repetitive assembly work, particularly
when high levels of precision are needed, can lead to a higher output using less labour.
Again, only businesses that have reached a certain size will be able to justify purchase
of this type of machinery.
• Better and bigger transport methods can reduce distribution costs per unit. For
example, when a business is over a certain size, making deliveries with a lorry instead
of a van may produce cost savings. It will reduce the number of trips and the amount of
labour required to deliver goods.
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Specialisation economies
As a firm becomes larger it is more able to obtain the advantage of division of labour. This means that
the business is organised in such a way that, to a greater extent, staff can concentrate on one kind
of work. This in turn enables them to become more skilled and quicker at that work. This will reduce
labour cost per unit.
For example, consider a very small farm, where the farmer has no employees. The farmer spends time
on a wide range of jobs. He or she will have to deal with paperwork, look after animals and work with
a tractor. If the farmer can acquire more land and operate on a significantly larger scale, the farmer
will need to employ staff. One of these staff may be a tractor driver, who does a much narrower range
of jobs than the farmer. Because there is more division of labour, the tractor driver is very quick and
efficient when it comes to using big tractors on various tasks. He does it all the time, whereas the
farmer only used to do it some of the time.
Another type of specialisation economy arises when a business has reached a size where it has become
viable to employ specialist expertise rather than use an independent contractor. For example, smaller
firms use the service of an independent accountant from time to time because there is not enough
accounts work within the business to justify employing an accountant. If the business reaches a certain
size, there may be enough work. The hourly rate of pay for an employed accountant will be less than
that for a self employed accountant. Also, the employed accountant will have a better understanding
of the business. The same principle applies to other specialists such as marketing managers, engineers
and qualified human resources managers.
Purchasing economies
Large firms can buy raw materials and other inputs in greater bulk. Suppliers will be keen to offer price
discounts to those businesses they see as big customers. Not only that, the managers of a business that
has been around for a time will manage costs better. The managers have learnt from experience. The
owners of a small business start-up, on the other hand, are still learning and making mistakes as they go
along.
An example of this can be seen in the life story of Alan Sugar. He started out as an electronics
manufacturer in his twenties on the first floor of a small London garment factory. With limited
expertise, he made some mistakes early on. His early amplifiers worked but produced poor sound
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quality and did not sell very well. He had optimistically purchased enough parts to make 2000 of the
amplifiers, though actual sales were far less than this. By the time he was in his forties, and running a
sizeable company, Sugar’s years of experience meant that he was far less likely to make mistakes of this
kind.
The advantages of economies of scale
Lower unit costs
Achieving economies of scale is important because this enables a business to reduce its unit costs. This
gives a business two options:
• It can offer customers a reduced price. This could mean increased demand and higher
total profits. It could also mean a competitive advantage over other firms in the market.
• Or it could keep prices the same and accept a better profit margin.
Barriers to entry
Very large businesses are able to deter other businesses from entering the market in the short run. It
is difficult to set up a business to compete in mass markets with businesses such as Kelloggs (breakfast
cereals), Microsoft (computer operating systems), and Johnson and Johnson (pharmaceuticals)
because their sheer scale of operations enables them to create barriers to entry. Where threats to the
dominance of large companies emerge, they can use their economies of scale to attempt to eliminate
rivals. A price war occurs when a business aggressively cuts prices to try and gain market share from its
rivals. A large company is better placed to win a price war than a smaller business with less capital and
higher unit costs.
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Activity 3.12.1 Munchester Taxis
Ten years ago, John and Lyn Bates set up in business as a taxi firm in Munchester. The company is imaginatively
named Munchester Taxis. To begin with, they just employed one person, George Osborne, an old friend of
John’s. George and John drove the cars while Lyn looked after the phone. With a lot of hard work and ups and
downs, the couple have built up the company so that today it employs twenty full-time and forty part- time
drivers. Munchester Taxis has a big enough fleet of vehicles to justify employing a mechanic to service and
repair the cars at the company premises. The garage is well equipped, so there is rarely any need to send cars
anywhere else for repair. Lyn leads a small team in the booking office, using special software for bookings. As
well as normal taxis, the company runs four luxurious stretch limousines. John and Lyn do not compete on
price with other taxi firms but seek to provide the best customer service. Their drivers are required to be
smartly dressed and present a positive image of the company at all times.
TASK
1. Analyse what economies of scale might have been achieved by Munchester Taxis since it first started
trading. (8)
Taxi!
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